Chapter Objectives
Chapter 6. Short Term Credit
Management
Major Topics
Arranging and Using Credit
Revolving Credit
Installment Credit
Obtaining Credit and Resolving Credit
Problems
To evaluate reasons for and against using credit and
decide whether or not credit is appropriate for you.
To be able to take the necessary steps to establish
credit and develop a credit history.
To identify what is meant by revolving credit and
how it is used.
To understand how to use credit cards properly and
to know your legal rights as a borrower against credit
mistakes.
To learn how installment credit works.
To compare the various sources of credit and to learn
what to do if you experience credit problems.
Reasons for Using Credit
As a Shopping Convenience
Especially good for record keeping, rebates, other benefits
To Increase Total Consumption
Actual borrowing
As an Inflation Hedge
Buy now to avoid higher future prices
As a Source of Emergency Funds
If you don’t have 3-6 months of liquid assets …
Disadvantages of Using Credit
How to Get Credit
Consider what the lender looks for (3 C’s)
Temptation to overspend
All too common. Keep in mind credit needs to be repaid
with interest! It’s not free money!
Credit costs
Some can be very high
Less flexibility with future budgets
When you borrow, you are borrowing against your future
income.
Character: previous obligations
Capital: financial assets
Capacity: future obligations
Begin a credit record.
Open savings and checking accounts.
Open a retail charge account.
Qualify for a small installment loan.
Make sure your credit records follow you.
Have a telephone installed.
Review your credit report.
Repair a bad credit record.
Special Concerns for Spouses
Establishing Credit
Make sure your credit history is in your name. Don’t use a
social title. ex., Mrs.Edward Hall
Inform creditors that you wish to maintain your own credit
history.
Know the difference between a joint and individual credit
account.
Joint Credit Account:
• Both spouses responsible for debt.
• Divorced or separated spouses should cancel joint accounts.
The Role of the Credit Bureau
Does not decide who receives credit.
Stores information on past use of credit
Stores information on legal actions against
you.
Sells credit reports to lenders.
Individual Credit Account
• Only you are responsible for debt.
• Account will appear only on you credit report.
Contents of a Credit Report
Credit Report
The three largest credit bureaus
Existing credit accounts
Information on each credit account includes
credit limit, loan amount and account balance
who is responsible for paying the account
Public record information
bankruptcies, tax liens and monetary judgments
Who has obtained a copy
If You are Denied Credit
Obtain a copy of your report.
Correct any mistakes.
Submit your own statement on disputed
claims.
Have adverse information that is old
removed from report.
Have those who received report notified of
any incorrect entries.
Equifax: http://www.equifax.com
Trans Union: http://www.transunion.com
Experian: http://www.experian.com
Now consumers can obtain credit reports for free once a year.
For more information about credit, visit Federal Trade Commission
Website at
http://www.ftc.gov/bcp/conline/edcams/credit/index.html
For your free credit report, visit
https://www.annualcreditreport.com/cra/index.jsp
Credit report and credit score are used for many purposes
(insurance, job, rental, etc.) these days. In addition, identity
theft is becoming a major consumer fraud issue. You need to be
diligent about checking your credit report. It is a good idea to
obtain one credit report every four months, rotating among the
three credit bureaus.
Credit Accounts
Revolving credit account
An open-end account with an established
line of credit and rules for minimum
payments.
Retail installment account
An closed-end account that has a separate
installment contract for each purchase
Revolving Credit Account
Credit limit determined by credit record and
net worth.
Partial payment must be made each month.
Interest charged on unpaid balance.
Account may never actually be paid off.
Interest Computation Methods
Previous balance method
Rate applied to balance at end of previous month.
Adjusted balance method
Equal to the previous balance less any payments or returns made
during the current billing cycle
Average daily balance method (most common)
including current purchases
excluding current purchases
Truth in Lending Act
Annual percentage rate (APR) applied to
balance.
Method for calculating interest.
Grace period, if any.
Minimum monthly payment, and penalties
for late payment.
Permission to investigate credit history.
Major Issuers of Credit Cards
Bank Credit Cards
Discover
MasterCard
Visa
Travel & Entertainment Cards
American Express
Other Cards
Two-cycle average daily balance method
Eliminates a grace period in the previous month when you fail to
completely pay off the balance in the present month.
Can go back two periods to collect interest on unpaid balance.
Credit Card Cost Comparison
Annual membership
fee
Variable rate
information
Balance computation
method
Late payment fee
Copy charge
Required Information on
Revolving Charge Account
Annual percentage
rate
Grace period
Cash advance fee
Over-the-limit penalty
Replacement fee
Fees for optional
services
Department store chains
Major gasoline retailers
Credit Card Benefit Comparison
Credit limit
Disability insurance
Accident insurance
Rental car collision
insurance
Warranty protection
Merchandise loss
protection
Credit life
Rebates &
discounts
Frequent flyer
miles
Credit card registry
Purchase price
protection
Payback Period
$3,000 Credit Balance @ 19% APR
Monthly
Payment
$60
75
100
125
Months
Total Interest
100
64
42
31
$2,991
1,790
1,102
804
Correcting Credit Mistakes
Notify the creditor in writing within 60 days after bill was
mailed.
Pay parts of the bill that are not in dispute.
Creditor will notify you within 30 days of its decision.
If no error is found, you must pay or you will be reported
as delinquent.
If you still challenge in writing the creditor must report
that information.
Provide credit bureau with your explanation of the dispute.
Debit Cards
Bank deposit is immediately reduced
You do not have the protections afforded
credit card purchases
Lost or stolen credit cards are covered by the
Electronic Funds Transfer Act
you can lose up to $500 if you fail to notify issuer
within two days after learning of theft
if you wait 60 days your losses may be unlimited
Protect Against Credit Card Fraud
Record card numbers, expiration dates and
phone number for card company.
Destroy old bills, receipts and credit cards.
Check sales receipt and compare with credit
card statement.
Be careful giving out your card number.
Report lost and stolen cards immediately.
Other Credit Terms
Chargeback
a disputed amount charged back to the
merchant by the credit card company.
Credit blocking
a reduced credit limit based upon an
expected purchase
Installment Credit
Repay the debt by
A series of uniform payments called
installments
Elements of a retail installment contract
Promissory note
Security agreement
Methods for Charging Interest
Simple Interest Method
percentage rate applied to outstanding
loan balance
Discount Method
interest deducted from credit extended you
Add-on Method
interest added to amount borrowed at
beginning of loan
Discount Method
Need $1,000
Borrow $1,136.36 at 12% simple
interest
1000/(1-12%)=1136.36
Monthly payment: 1136.36/12=$94.72
Annual Percentage Rate (APR)
Same as annual simple interest.
Takes into consideration fees and methods
of computation
In the previous example:
Simple interest: APR=12%
Discount: APR=24.28%
Add-on: APR=21.46%
In credit shopping, compare APRs!!!
Figure. A 12-month installment loan with
annual simple interest of 12 percent
Monthly Outstanding
Balance
Monthly
Payment
Finance
Loan
Charge Repayment
1
$1,000.00
$88.85
$10.00
2
921.15
88.85
9.21
....
...
...
...
$78.85
79.85
...
11
175.07
88.85
1.75
12
87.97
88.85
0.88
87.97
$1,066.19
$66.19
$1,000
Total
87.10
Add-on Method
Need $1,000
Total payments= $1,120 for 12%
simple interest
1000*(1+12%)=1,120
Monthly payment: 1120/12=$93.33
Sources of Credit
Banking Institutions
Overdraft protections
Unsecured personal loans
Home equity line of credit
Consumer Finance Companies
Specialized loans (GM cars)
Other
Life insurance policies
Margin accounts on stocks and bonds
Pawnbroker
A Credit Management Strategy
Use the grace period.
Avoid expensive credit on revolving charge
accounts.
Take a broad view of credit sources.
Carefully consider the use of variable rate
loans.
If You have Personal Debt
Problems – Credit Counseling
National Foundation of Credit Counseling
http://www.nfcc.org
The only Utah location is in St. George
• Credit Counseling of Utah, 163 West 1600 South #2
Saint George, UT 84770 (800) 451-4505
Utah State University Family Life Center:
Housing and Financial Counseling
http://www.usu.edu/fchd/hfc.cfm
Last Resort - Bankruptcy
What a counselor will do:
Develop a budget and a repayment plan to
repay debt
Negotiate a more reasonable repayment
plan with the lenders
Bankruptcy statistics
American Bankruptcy Institution: http://www.abiworld.org/
Straight Bankruptcy (Chapter 7)
Primary form of bankruptcy.
Discharges all debts and provides a fresh start.
Homeowner’s equity and some personal assets
may be partially protected.
Cannot file again for 6 years.
Record remains on credit report for 10 years.
Utah’s Bankruptcy Situation
Wage Earner Plan (Chapter 13)
Repayment schedule established by court.
Debtor may retain property.
Lenders receive partial or total repayment over
3-5 year period.
Remains on credit report for 7 years.
Assignment for Chapter 6
If you have never obtained a copy of
your credit report, you should try to get a
copy. For a free copy go to
https://www.annualcreditreport.com/cra/i
ndex.jsp
Take a close look at the credit cards you
have. What’s the interest rate? What is
the balance computation method? What’s
the grace period? Compare your credit
cards using the list of costs and benefits
National Rank is #1 in 2003 and
previous years – 1 in 36.5 households
filed for bankruptcy in 2003:
http://www.abiworld.org/statcharts/Hou
seRank.htm
Utah-specific laws:
http://www.utahbankruptcylaw.com/